10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10–Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2001

Commission file number 000–25475

LATITUDE COMMUNICATIONS, INC.

(Exact name of registrant as specified in its charter)

Delaware	94–3177392
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

2121 Tasman Drive, Santa Clara, CA 95054

(Address of principal executive offices, including zip code)

(408) 988–7200

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes ý                    No o

As of November 5, 2001, there were 19,388,000 shares of the registrant’s Common Stock outstanding.

INDEX

PART I.	FINANCIAL INFORMATION
	Item 1.	Financial Statements
		Condensed consolidated balance sheets at September 30, 2001 and December 31, 2000
		Condensed consolidated statements of operations and comprehensive income (loss) for the three months ended September 30, 2001 and 2000; and for the nine months ended September 30, 2001 and 2000
		Condensed consolidated statements of cash flows for the nine months ended September 30, 2001 and 2000
		Notes to condensed consolidated financial statements
	Item 2.	Management’s Discussion and Analysis of Financial Conditionand Results of Operations
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk
PART II.	OTHER INFORMATION
	Item 1.	Legal Proceedings
	Item 2.	Changes in Securities and Use of Proceeds
	Item 3.	Defaults Upon Senior Securities
	Item 4.	Submission of Matters to a Vote of Security Holders
	Item 5.	Other Information
	Item 6.	Exhibits and Reports on Form 8K
SIGNATURE

PART I.         FINANCIAL INFORMATION

Item 1.            Financial Statements.

LATITUDE COMMUNICATIONS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except per share data)

	September 30, 2001			December 31, 2000
ASSETS	(Unaudited)
Current assets:
Cash and cash equivalents	$	15,191		$	23,993
Short–term investments	8,948			14,203
Accounts receivable, net	6,485			10,044
Inventory	2,015			1,662
Prepaids and other assets	2,102			2,790
Deferred tax assets	2,751			2,779
Total current assets	37,492			55,471
Property and equipment, net	4,907			4,062
Long–term investments	10,044			2,301
Deferred tax assets	3,990			794
Deposits and other long-term assets	1,010			530
Total assets	$	57,443		$	63,158
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	624		$	875
Accrued liabilities	5,037			3,565
Deferred revenue	5,180			6,434
Current portion of long–term debt	257			362
Total current liabilities	11,098			11,236
Long–term debt	—			106
Total liabilities	11,098			11,342
Stockholders’ equity:
Preferred stock, $0.001 par value
Authorized: 5,000 shares at September 30, 2001 and December 31, 2000
Issued and outstanding: No shares at September 30, 2001 and December 31, 2000	—			—
Common stock, $0.001 par value
Authorized: 74,860 and 75,000 shares at September 30, 2001 and December 31, 2000, respectively
Issued and outstanding: 19,284 and 19,302 shares at September 30, 2001 and December 31, 2000, respectively	19			19
Additional paid–in capital	57,645			57,675
Notes receivable from common stockholders	(5		)	(10		)
Deferred stock compensation	(301		)	(620		)
Accumulated other comprehensive income	160			46
Accumulated deficit	(11,173		)	(5,294		)
Total stockholders’ equity	46,345			51,816
Total liabilities and stockholders’ equity	$	57,443		$	63,158

The accompanying notes are an integral part of these condensed consolidated financial statements.

LATITUDE COMMUNICATIONS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
(in thousands, except per share amounts)
(Unaudited)

	Three Months Ended September 30,						Nine Months Ended September 30,
	2001			2000			2001			2000
Revenue:
Product	$	1,640		$	6,413		$	10,780		$	22,107
Service	4,984			3,750			14,313			10,110
Total revenue	6,624			10,163			25,093			32,217
Cost of revenue:
Product	651			990			2,328			3,722
Service (includes non-cash stock compensation of $2, $2, $6 and $24, respectively)	2,761			1,976			7,915			5,278
Total cost of revenue	3,412			2,966			10,243			9,000
Gross profit	3,212			7,197			14,850			23,217
Operating expenses:
Research and development (includes non-cash stock compensation of $16, $18, $51 and $57, respectively)	1,425			1,342			4,596			4,483
Marketing and sales (includes non-cash stock compensation of $23, $24, $45 and $75, respectively)	4,635			4,889			15,401			14,283
General and administrative (includes non-cash stock compensation of $63, $68, $193 and $198, respectively)	1,332			1,013			4,492			2,868
Restructuring charge	—			—			870			—
Total operating expenses	7,392			7,244			25,359			21,643
Income (loss) from operations	(4,180		)	(47		)	(10,509		)	1,583
Interest income, net	387			600			1,436			1,769
Income (loss) before benefit from (provision for) income tax	(3,793		)	553			(9,073		)	3,352
Benefit from (provision for) income tax	1,328			(253		)	3,194			(1,409		)
Net income (loss)	$	(2,465	)	$	300		$	(5,879	)	$	1,943
Other comprehensive income, net of tax—
Unrealized gain on securities	147			178			115			61
Cumulative translation adjustment	(27		)	—			(3		)	—
Comprehensive income (loss)	$	(2,345	)	$	478		$	(5,767	)	$	2,004
Net income (loss) per share—basic	$	(0.13	)	$	0.02		$	(0.30	)	$	0.10
Shares used in per share calculation—basic	19,415			18,718			19,411			18,693
Net income (loss) per share—diluted	$	(0.13	)	$	0.02		$	(0.30	)	$	0.10
Shares used in per share calculation—diluted	19,415			19,827			19,411			19,929

The accompanying notes are an integral part of these condensed consolidated financial statements.

LATITUDE COMMUNICATIONS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)
(Unaudited)

	Nine months Ended September 30,
	2001			2000
Cash flows from operating activities:
Net income (loss)	$	(5,879	)	$	1,943
Adjustments to reconcile net income (loss) to net cash used in operating activities:
Depreciation and amortization	1,869			1,240
Amortization of capitalized software	416			—
Provision for excess and obsolete inventory	—			258
Provision for doubtful accounts	800			139
Amortization of deferred stock compensation	295			354
Deferred income taxes	(3,230		)	—
Change in deferred revenue	(1,254		)	280
Changes in operating assets and liabilities:
Accounts receivable	(2,745		)	(4,778		)
Inventory	(353		)	(953		)
Prepaids and other assets	272			(726		)
Accounts payable	(251		)	(77		)
Accrued liabilities	1,472			1,211
Net cash used in operating activities	(3,098		)	(1,109		)
Cash flows from investing activities:
Purchases of property and equipment	(2,714		)	(2,489		)
Purchases of available for sale securities	(32,787		)	(26,649		)
Maturities of available for sale securities	30,475			33,626
Increase in deposits and other long-term assets	(480		)	(97		)
Net cash provided by (used in) investing activities	(5,506		)	4,391
Cash flows from financing activities:
Proceeds from issuance of common stock	205			863
Repurchase of common stock	(197		)	—
Repayment of notes receivable from common stockholders	5			51
Repayment of notes payable and capital lease obligations	(211		)	(428		)
Other	—			(20		)
Net cash provided by (used in) financing activities	(198		)	466
Net decrease in cash and cash equivalents	(8,802		)	(3,748		)
Cash and cash equivalents, beginning of period	23,993			10,847
Cash and cash equivalents, end of period	$	15,191		$	14,595

The accompanying notes are an integral part of these condensed consolidated financial statements.

LATITUDE COMMUNICATIONS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 1—The Company and Basis of Presentation

Latitude Communications, Inc. (the "Company") is a leading provider of enterprise e-conferencing solutions. The Company develops, markets and supports its MeetingPlace system and services, which enables real-time collaboration through meetings via Web browsers, groupware applications such as Outlook and Notes, and PSTN and IP phones. MeetingPlace also allows users to share and edit live documents, record, and access meeting content. Highly scalable and designed to be deployed as part of a company's standard communications infrastructure, MeetingPlace can support tens of thousands of users. The Company distributes its product and services through distributors and a direct sales force to companies across many industries in the United States, Europe and Asia.

The accompanying unaudited condensed consolidated financial statements reflect all adjustments which, in the opinion of management, are necessary for a fair presentation of the results for the periods shown. The results of operations for such periods are not necessarily indicative of the results expected for the full fiscal year or for any future period. The balance sheet at December 31, 2000 was derived from audited financial statements, however, it does not include all disclosures required by generally accepted accounting principles in the United States of America.

The financial statements and related disclosures have been prepared with the presumption that users of the interim financial information have read or have access to the audited financial statements for the preceding fiscal year. Accordingly, these financial statements should be read in conjunction with the audited financial statements and the related notes thereto contained in the Company's Annual Report on Form 10-K for the year ended December 31, 2000.

Note 2—Recent Accounting Pronouncements

In July 2001, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 141 (“SFAS 141”), “Business Combinations.” SFAS 141 requires the purchase method of accounting for business combinations initiated after June 30, 2001 and eliminates the pooling-of-interests method.

In July 2001, the FASB issued Statement of Financial Accounting Standards No. 142 (“SFAS 142”), “Goodwill and Other Intangible Assets”, which is effective for fiscal years beginning after March 15, 2001. SFAS 142 requires, among other things, the discontinuance of goodwill amortization. In addition, the standard includes provisions upon adoption for the reclassification of certain existing recognized intangibles as goodwill, reassessment of the useful lives of existing recognized intangibles, reclassification of certain intangibles out of previously reported goodwill and the testing for impairment of existing goodwill and other intangibles. We believe that the adoption of SFAS 142 will not have a significant impact on our financial position and results of operations.

In August 2001, the FASB issued Statement of Financial Accounting Standards No. 143 (“SFAS 143”), “Accounting for Asset Retirement Obligations”. SFAS 143 requires, among other things, retirement obligations to be recognized when they are incurred and displayed as liabilities, with a corresponding amount capitalized as part of the related long-lived asset. The capitalized element is required to be expensed using a systematic and rational method over its useful life. SFAS 143 will be adopted by the Company in the first quarter of fiscal 2002 and is not expected to have a significant impact on the Company’s financial position or results of operations.

In October 2001, the FASB issued Statement of Financial Accounting Standards No. 144 (“SFAS 144”), "Accounting for the Impairment or Disposal of Long-Lived Assets". SFAS 144 supercedes Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." SFAS 144 applies to all long-lived assets, including discontinued operations, and consequently amends Accounting Principles Board Opinion No. 30, "Reporting Results of Operations Reporting the Effects of Disposal of a Segment of a Business". SFAS 144 develops one accounting model for long-lived assets that are to be disposed of by sale. SFAS 144 requires that long-lived assets that are to be disposed of by sale be measured at the lower of book value or fair value less selling costs. Additionally, SFAS 144 expands the scope of discontinued operations to include all components of an entity with operations that (1) can be distinguished from the rest of the entity and (2) will be eliminated from the ongoing operations of the entity in a disposal transaction. The provisions of SFAS 144 are required to be adopted during the Company’s fiscal year beginning January 1, 2002. The Company does not expect the adoption of SFAS 144 to have a significant impact on its financial position or results of operations.

Note 3—Inventory

	September 30, 2001		December 31, 2000
	(Unaudited)
Raw materials	$	1,505	$	1,216
Finished goods	510		446
	$	2,015	$	1,662

Note 4—Net Income (Loss) Per Share

Basic net income (loss) per share is computed by dividing net income (loss) available to common stockholders by the weighted average number of vested common shares outstanding for the period. Diluted net income (loss) per share is computed giving effect to all potentially dilutive common shares, including options, warrants and preferred stock.

A reconciliation of the numerator and denominator of basic and diluted EPS is provided as follows (in thousands, except per share amounts).

	Three Months Ended September 30					Nine Months Ended September 30,
	2001			2000		2001			2000
	(Unaudited)					(Unaudited)
Net income (loss) per share, basic and diluted:
Numerator for net income (loss), basic and diluted	$	(2,465	)	$	300	$	(5,879	)	$	1,943
Denominator for basic net income (loss) per share:
Weighted average vested common shares outstanding	19,415			18,718		19,411			18,693
Net income (loss) per share basic	$	(0.13	)	$	0.02	$	(0.30	)	$	0.10
Denominator for diluted earnings per share:
Weighted average vested common shares outstanding	19,415			18,718		19,411			18,693
Effect of dilutive securities:
Nonvested common shares	—			419		—			379
Common stock options	—			657		—			819
Warrants	—			33		—			38
Weighted average common and common equivalent shares	19,415			19,827		19,411			19,929
Net income per share diluted	$	(0.13	)	$	0.02	$	(0.30	)	$	0.10
Securities not included in the calculation of diluted EPS because the effect is anti-dillutive:
Nonvested common shares	77			—		403			—

Note 5—Restructuring

During the quarter ended June 30, 2001, the Company initiated a restructuring program. As a part of this restructuring program, the Company recorded costs and other charges of $870,000 classified as operating expenses.  Of this amount, $442,000 related to a reduction in the workforce by approximately 40 regular employees across all functional areas of the Company, $228,000 related primarily to non-cancellable lease costs arising from the consolidation of excess facilities and $200,000 related to asset write-offs.

 A summary of the restructuring costs is as follows (in thousands):

	Severance and Benefits			Facilities and Other Charges			Asset Write-Offs			Total
Restructuring reserve balance at June 30, 2001	$	442		$	228		$	200		$	870
Cash paid during the quarter	(222		)	(35		)	—			(257		)
Non-cash charges	(31		)	—			(200		)	(231		)
Restructuring reserve balance at September 30, 2001	$	189		$	193		$	—		$	382

The remaining cash expenditures relating to workforce reductions, and other charges will be substantially paid in the fourth quarter of fiscal 2001. The amounts related to non-cancelable lease costs will be paid over the respective lease terms through fiscal 2003.

Note 6 – Share Repurchase Program

On July 24, 2001 the Company’s Board of Directors approved a Share Repurchase Program of up to 1,000,000 shares of common stock.  As of September 30, 2001, the Company has purchased 140,400 shares under this program at a weighted average cost of $1.41.

Item 2.            Management’s Discussion and Analysis of Financial Condition and Results of Operations.

This Management's Discussion and Analysis of Financial Condition and Results of Operations and other parts of this Form 10-Q include a number of forward-looking statements that reflect our current views with respect to future events and financial performance. We use words such as "anticipates," "believes," "expects," "future," and "intends," and similar expressions to identify forward-looking statements. You should not place undue reliance on these forward-looking statements, which apply only as of the date of this Quarterly Report on Form 10-Q. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from historical results or our predictions. These risks are described in " Factors Affecting Future Operating Results " and elsewhere in this Form 10-Q. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management's analysis only as of the date hereof. The Company assumes no obligation to update these forward-looking statements to reflect actual results or changes in factors or assumptions affecting such forward-looking statements.

Overview

We are a leading provider of enterprise e-conferencing solutions that enable geographically dispersed  organizations to collaborate in real time. The Company's award-winning MeetingPlace system is designed for enterprise-wide deployment to improve the ability of employees, partners, and customers to meet and work. With MeetingPlace, participants can schedule and attend a meeting, view, share and edit documents, and capture and  retrieve meeting content. MeetingPlace is designed to be an enterprise-wide resource and to leverage existing technologies such as telephones, cellular phones and personal computers.

We generate revenue from sales of our MeetingPlace products and from customer support, hosting and consulting services. Revenue derived from product sales constituted 25% of total revenue in the third quarter of 2001 and 63% during the corresponding period of 2000. Product revenue is generally recognized upon shipment if a signed contract exists, the fee is fixed or determinable, collection of the resulting receivable is reasonably assured, product returns are reasonably estimable and, if applicable, acceptance has been obtained. We calculate an allowance for returns based on historical rates. Service revenue includes revenue from hosting, implementation and integration services, system management services, warranty coverage and customer support. Revenue from hosting, implementation and system integration services is recognized as the services are performed, while revenue from system management services, warranty coverage and customer support is recognized ratably over the period of the contract. Beginning in 2001, we have expanded our service offerings by providing hosted services to our customers. Accordingly, future revenue from this new service offering will increase the proportion of total revenue derived from services. To the extent that prospective customers elect to purchase the hosted service rather than an on-premises MeetingPlace system, our product revenue could be adversely affected.

We sell our MeetingPlace products and services primarily through our direct sales force and, to a lesser extent, through indirect distribution channels. The majority of our revenue is derived from Fortune 1000 companies, many of which initially purchase MeetingPlace servers and later expand deployment of our products as they require additional capacity for voice and web conferencing. In 1997, we expanded into international markets by opening a sales and support office in the United Kingdom and establishing distributor relationships in Hong Kong and Singapore, and in 1998, we established a distributor relationship in Australia. While we intend to increase sales through indirect channels and internationally, we cannot assure you that we will be successful. In 1998, we expanded the breadth of our support services by establishing a consulting services group to provide expanded implementation services, system management services and customized project consulting. In 1999, we opened a sales and support office in Singapore. In addition, in 1999 and 2000, we increased our distribution partners to include global partnerships, application service providers and partners focused on the U.S. federal government.

Total cost of revenue consists of component and materials costs, direct labor costs, warranty costs, royalties and overhead related to manufacturing of our products, as well as materials, travel and labor costs related to personnel engaged in our service operations. Product gross margin is impacted by the proportion of product revenue derived from software sales, which typically carry higher margins than hardware sales, and from indirect distribution channels, which typically carry lower margins than direct sales. Service gross margin is impacted by the mix of services we provide, which have different levels of profitability, and the efficiency with which we provide support to our customers. We record an allowance for excess and obsolete inventory by identifying inventory components either considered excess based on estimates of future usage or obsolete due to changes in our products. As a result of technological changes, our products may become obsolete or we could be required to redesign our products.

Results Of Operations

The following table lists, for the periods indicated, the percentage of total revenue of each line item from our condensed consolidated statement of operations to total revenues:

	Three Months Ended September 30,				Nine months Ended September 30,
	2001		2000		2001		2000
Revenue:
Product	24.8	%	63.1	%	43.0	%	68.6	%
Service	75.2		36.9		57.0		31.4
Total revenue	100.0		100.0		100.0		100.0
Cost of revenue:
Product	9.8		9.7		9.3		11.5
Service	41.7		19.5		31.5		16.4
Total cost of revenue	51.5		29.2		40.8		27.9
Gross profit	48.5		70.8		59.2		72.1
Operating expenses:
Research and development	21.5		13.2		18.3		13.9
Marketing and sales	70.0		48.1		61.4		44.4
General and administrative	20.1		10.0		17.9		8.9
Restructuring charge	0.0		0.0		3.4		0.0
Total operating expenses	111.6		71.3		101.0		67.2
Income (loss) from operations	(63.1	)	(0.5	)	(41.8	)	4.9
Interest income, net	5.9		5.9		5.7		5.5
Income (loss) before benefit from (provision) for income taxes	(57.2	)	5.4		(36.1	)	10.4
Benefit from (provision for) income taxes	20.0		(2.5	)	12.7		(4.4	)
Net income (loss)	(37.2	)%	2.9	%	(23.4	)%	6.0	%

Product Revenue

Product revenue decreased $4.8 million, or 74%, to $1.6 million for the three months ended September 30, 2001 from $6.4 million for the three months ended September 30, 2000. Product revenue decreased $11.3 million, or 51%, to $10.8 million for the nine months ended September 30, 2001 from $22.1 million for the nine months ended September 30, 2000. The decreases were due primarily to reduced capital spending and longer sales cycles at our existing and potential customers, resulting in fewer MeetingPlace systems sales in the current year.  These factors were magnified in the quarter ended September 30, 2001 by the terrorist attacks of September 11, 2001.  International sales represented approximately 35.2% and 4.8% of product revenue in the three months ended September 30, 2001 and 2000, respectively, and approximately 19.8% and 8.9% of product revenue in the nine months ended September 30, 2001 and 2000, respectively. The increase in the percentage of international product revenue is primarily due to the decline in total revenue.

Service Revenue

Service revenue increased $1.2 million, or 33%, to $5.0 million for the three months ended September 30, 2001 from $3.8 million for the three months ended September 30, 2000. Service revenue increased $4.2 million, or 42%, to $14.3 million for the nine months ended September 30, 2001 from $10.1 million for the nine months ended September 30, 2000.  The increases were attributable primarily to growth in our customer base during this period, which led to increased sales of full care support services, as well as the introduction of additional services such as hosted and managed services. We expect service revenue to continue to increase in absolute dollars.

Total Cost of Revenue

Total cost of revenue increased $400,000, or 15%, to $3.4 million for the three months ended September 30, 2001 from $3.0 million for the three months ended September 30, 2000.  Total cost of  revenue increased $1.2 million or 14%, to $10.2 million for the nine months ended September 30, 2001 from $9.0 million for the nine months ended September 30, 2000.  The increase in total cost of revenue year to date was attributable primarily to a change in the mix of revenues from higher margin product revenue to lower margin service revenue, and we expect this trend to continue.

Gross profit decreased $4.0 million, or 55%, to $3.2 million for the three months ended September 30, 2001 from $7.2 million for the three months ended September 30, 2000. Gross profit decreased $8.4 million, or 36%, to $14.9 million for the nine months ended September 30, 2001 from $23.2 million for the nine months ended September 30, 2000.  Gross profit decreased to 48.5% as a percentage of revenue for the three months ended September 30, 2001 from 70.8% for the three months ended September 30, 2000. Gross profit decreased to 59.2% as a percentage of revenue for the nine months ended September 30, 2001 from 72.1% for the nine months ended September 30, 2000. The decline in gross profit is due to the decline in product revenue.

Product gross profit decreased to 60.3% as a percentage of product revenue for the three months ended September 30, 2001 from 84.6% for the three months ended September 30, 2000. Product gross profit decreased to 78.4% as a percentage of revenue for the nine months ended September 30, 2001 from 83.2% for the nine months ended September 30, 2000. We expect that product gross margin may continue to be lower than historical levels in the future due in part to potential pricing pressure as well as overhead costs spread over fewer MeetingPlace systems.

Service gross profit decreased to 44.6% as a percentage of service revenue for the three months ended September 30, 2001 from 47.3% for the three months ended September 30, 2000. Service gross profit decreased to 44.7% as a percentage of revenue for the nine months ended September 30, 2001 from 47.8% for the nine months ended September 30, 2000.  We expect the future service gross profit percentage to generally range from 44% to 50% of service revenue.

Research and Development Expenses

Research and development expenses consist primarily of compensation and related costs for research and development personnel, facilities expenses for testing space and equipment and purchased software. Research and development expenses increased $100,000, or 6%, to $1.4 million for the three months ended September 30, 2001 from $1.3 million for the three months ended September 30, 2000. Research and development expenses increased $100,000, or 3%, to $4.6 million for the nine months ended September 30, 2001 from $4.5 million for the three months ended September 30, 2000.  As a percentage of total revenues, research and development expenses were 21.5% and 13.2% for the three months ended September 30, 2001 and 2000 and were 18.3% and 13.9% for the nine months ended September 30, 2001 and 2000. The increase in research and development expenses as a percentage of total revenues was due primarily to a decline in total revenues. We expect to continue to make substantial investments in research and development and anticipate that research expenses will continue to increase in absolute dollars.

Marketing and Sales Expenses

Marketing and sales expenses consist primarily of promotional expenditures and compensation and related costs for marketing and sales personnel. Marketing and sales expenses decreased $300,000, or 5%, to $4.6 million for the three months ended September 30, 2001 from $4.9 million for the three months ended September 30, 2000. Marketing and sales expenses increased $1.1 million, or 8%, to $15.4 million for the nine months ended September 30, 2001 from $14.3 million for the nine months ended September 30, 2000. As a percentage of total revenues, marketing and sales expenses were 70.0% and 48.1% for the three months ended September 30, 2001 and 2000 and were 61.4% and 44.4% for the nine months ended September 30, 2001 and 2000. The increase in marketing and sales expenses as a percentage of revenue was due primarily to decreased revenue. The decrease in absolute dollars between the three months ended September 30, 2001 and 2000 is due primarily to lower commission expenses on lower revenues.  The increases in absolute dollars between the nine months ended September 30, 2001 and 2000 reflected increased employee related expenses in the sales and marketing organizations.

General and Administrative Expenses

General and administrative expenses consist primarily of personnel expenses, legal and accounting expenses and other general corporate expenses. General and administrative expenses increased $300,000, or 32%, to $1.3 million for the three months ended September 30, 2001 from $1.0 million for the three months ended September 30, 2000. General and administrative expenses increased $1.6 million, or 57%, to $4.5 million for the nine months ended September 30, 2001 from $2.9 million for the nine months ended September 30, 2000. As a percentage of total revenues, general and administrative expenses were 20.1% and 10.0% for the three months ended September 30, 2001 and 2000 and were 17.9% and 8.9% for the nine months ended September 30, 2001 and 2000. The increase in absolute dollars between the three months ended September 30, 2001 and the three months ended September 30, 2000 consisted primarily of $150,000 in incremental bad debt expense and $150,000 in incremental salaries and related costs. The increase in absolute dollars between the nine months ended September 30, 2001 and the nine months ended September 30, 2000 consisted primarily of $650,000 in incremental bad debt expense, $500,000 in incremental salaries and related costs, $150,000 in incremental insurance costs, as well as various other cost categories with smaller increases.

Amortization of Deferred Stock Compensation

In connection with the completion of our initial public offering in May 1999, options granted in the last quarter of 1997, 1998 and the first quarter of 1999 have been considered to be compensatory. Total remaining deferred stock compensation associated with these options as of September 30, 2001 amounted to $301,000. This amount is being amortized based on the remaining vesting period of these options and we expect amortization of approximately $90,000 over the remainder of 2001 and $201,000 in 2002 related to the options presently outstanding.

Interest Income, Net

Interest income, net of interest expense, decreased 36% to $387,000 for the three months ended September 30, 2001 from $600,000 for the three months ended September 30, 2000. Interest income, net of interest expense, decreased 19% to $1.4 million for the nine months ended September 30, 2001 from $1.8 million for the nine months ended September 30, 2000. The decrease in net interest income was attributable primarily to lower average yields on our portfolio of cash and investments.  We expect that projected use of cash and investments for working capital and capital equipment purchases totaling $8 million to $10 million during the next year will result in further declines in interest income.

Income Taxes

For the three months ended September 30, 2001, the benefit from income taxes was $1.3 million, compared to a provision of $253,000 in the three months ended September 30, 2000.  For the nine months ended September 30, 2001, the benefit from income taxes was $3.2 million, compared to a provision of $1.4 million in the nine months ended September 30, 2000.  Our effective tax rate was approximately (35)% for the three months and nine months ended September 30, 2001 and approximately 46% for the three months and 42% for the nine months ended September 30, 2000. The decline in the effective rate was due to certain minimum taxes payable even in a loss situation, which offset the benefit from income taxes otherwise available to offset the net loss in 2001.

Liquidity and Capital Resources

In May 1999, we completed an initial public offering of common stock, resulting in net proceeds to us of approximately $33.8 million. As of September 30, 2001, we had $34.2 million of cash, cash equivalents and investments, which represented 60% of total assets.

Cash used in operating activities was $2.8 million for the nine months ended September 30, 2001, compared to cash used in operating activities of  $1.1 million in the same period of 2000.  The difference between the net income (loss) for the period and net cash provided by or used in operating activities are non-cash items and changes in components of working capital.

Cash used in investing activities in the first nine months of 2001 was $5.9 million, which consisted primarily of the purchase of investments of $33.0 million and purchase of property and equipment of $2.7 million, partially offset by maturities of investments of $30.5 million. For the first nine months in 2000, cash provided by investing activities of $4.4 million consisted primarily of the purchase of investments of $26.7 million and purchase of property and equipment of $2.5 million, more than offset by maturities of investments of $33.6 million.

Cash used in financing activities in the first nine months of 2001 of $301,000 consisted primarily of repurchases of common stock of $197,000 and payments on obligations under capital leases and notes payable of $211,000, partially offset by proceeds from issuance of common stock under employee benefit plans of $102,000. For the first nine months of 2000, cash provided by financing activities of $374,000 consisted primarily of the proceeds from issuance of common stock under employee benefit plans of $863,000, partially offset by payments on obligations under capital leases and notes payable of $428,000.

We believe that our current cash, cash equivalents and marketable securities will be sufficient to meet our anticipated cash needs for working capital and capital expenditures for at least the next 12 months.

Impact of Recently Issued Accounting Standards

In July 2001, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 141 (“SFAS 141”), “Business Combinations.” SFAS 141 requires the purchase method of accounting for business combinations initiated after June 30, 2001 and eliminates the pooling-of-interests method.

In July 2001, the FASB issued Statement of Financial Accounting Standards No. 142 (“SFAS 142”), “Goodwill and Other Intangible Assets”, which is effective for fiscal years beginning after March 15, 2001. SFAS 142 requires, among other things, the discontinuance of goodwill amortization. In addition, the standard includes provisions upon adoption for the reclassification of certain existing recognized intangibles as goodwill, reassessment of the useful lives of existing recognized intangibles, reclassification of certain intangibles out of previously reported goodwill and the testing for impairment of existing goodwill and other intangibles. We believe that the adoption of SFAS 142 will not have a significant impact on our financial position and results of operations.

In August 2001, the FASB issued Statement of Financial Accounting Standards No. 143 (“SFAS 143”), “Accounting for Asset Retirement Obligations”. SFAS 143 requires, among other things, retirement obligations to be recognized when they are incurred and displayed as liabilities, with a corresponding amount capitalized as part of the related long-lived asset. The capitalized element is required to be expensed using a systematic and rational method over its useful life. SFAS 143 will be adopted by the Company in the first quarter of fiscal 2002 and is not expected to have a significant impact on the Company’s financial position or results of operations.

In October 2001, the FASB issued Statement of Financial Accounting Standards No. 144 (“SFAS 144”), "Accounting for the Impairment or Disposal of Long-Lived Assets". SFAS 144 supercedes Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." SFAS 144 applies to all long-lived assets, including discontinued operations, and consequently amends Accounting Principles Board Opinion No. 30, "Reporting Results of Operations Reporting the Effects of Disposal of a Segment of a Business". SFAS 144 develops one accounting model for long-lived assets that are to be disposed of by sale. SFAS 144 requires that long-lived assets that are to be disposed of by sale be measured at the lower of book value or fair value less selling costs. Additionally, SFAS 144 expands the scope of discontinued operations to include all components of an entity with operations that (1) can be distinguished from the rest of the entity and (2) will be eliminated from the ongoing operations of the entity in a disposal transaction. The provisions of SFAS 144 are required to be adopted during the Company’s fiscal year beginning January 1, 2002. The Company does not expect the adoption of SFAS 144 to have a significant impact on its financial position or results of operations.

Factors That May Affect Future Results

In addition to the other information in this report, the following factors should be considered carefully in evaluating the Company’s business and prospects:

Our future profitability is uncertain due to our limited operating history. We have a limited operating history and cannot assure you that our revenue will grow or that we will return to profitability in the future. Our financial statements must be considered in light of the risks and uncertainties encountered by companies in the early stages of development. We rely substantially on sales of our MeetingPlace products and services, which have limited market acceptance.

Recent economic developments have caused many companies to reduce headcount and overhead expenses and to reconsider or delay capital expenditures. This has had, and may continue to have, an adverse effect on our ability to grow revenue.

In addition, we are unable to predict our future product development, sales and marketing, and administrative expenses. To the extent that these expenses increase, we will need to increase revenue to sustain profitability. Our ability to increase revenue and achieve profitability also depends on the other risk factors described in this section.

Our operating results may fluctuate significantly. Our operating results are difficult to predict. Our future quarterly operating results may fluctuate and may not meet the expectations of securities analysts or investors. If this occurs, the price of our common stock would likely decline. The factors that may cause fluctuations of our operating results include the following:

·      changes in our mix of revenues generated from product sales and services;

·      changes by existing customers in their levels of purchases of our products and services;

·      changes in our mix of sales channels through which our products and services are sold; and

·      changes in our mix of domestic and international sales.

Additionally, we are expanding our service offerings by providing hosted services to our customers. Accordingly, future revenue from this new service offering will increase the proportion of total revenue derived from services. To the extent that prospective customers elect to purchase the hosted service rather than an on-premises MeetingPlace system, our product revenue could be adversely affected.

Orders at the beginning of each quarter typically do not equal expected revenue for that quarter. In addition, a significant portion of our orders is received in the last month of each fiscal quarter. If we fail to ship products by the end of a quarter in which the order is received, or if our prospective customers delay their orders or delivery schedules until the following quarter, we may fail to meet our revenue objectives.

Our market is highly competitive. Because of intense market competition, we may not be successful. Currently, our principal competitors include:

·      major telecommunications carriers that operate service bureaus for voice conferencing, such as AT&T Corp., MCI Worldcom, Inc. and Sprint Corporation;

·      private branch exchange, or PBX, vendors that sell systems with voice conferencing capabilities, such as Lucent Technologies Inc. and Nortel Networks; and

·      companies that offer web–based voice and data conferencing products and services.

Many of these companies have longer operating histories, stronger brand names and significantly greater financial, technical, marketing and other resources than we do. These companies also may have existing relationships with many of our prospective customers. In addition, these companies may be able to respond more quickly than we can to new or emerging technologies and changes in customer requirements.

In addition, we expect competition to persist and intensify in the future, which could adversely affect our ability to increase sales, penetrate new markets and maintain average selling prices. In the future, we may experience competition from potential competitors that include:

·      networking companies, such as Cisco Systems, Inc., 3Com Corporation, Lucent Technologies Inc. and Nortel Networks that are focusing on enabling the transmission of voice over the Internet and that may offer voice and web conferencing functionality; and

·      collaborative software providers, such as Microsoft Corporation and Lotus Development Corporation, that are focusing on web conferencing products and that may in the future incorporate voice conferencing functionality into their products.

Our market is in an early stage of development, and our products and services may not be adopted. If the market for our integrated voice and web conferencing products and services fails to grow or grows more slowly than we anticipate, we may not be able to increase revenues or return to profitability. The market for integrated real–time voice and web conferencing is relatively new and rapidly evolving. Our ability to be profitable depends in large part on the widespread adoption by end users of real–time voice and web conferencing.

We will have to devote substantial resources to educate prospective customers about the uses and benefits of our products and services. In addition, businesses that have invested substantial resources in other conferencing products may be reluctant or slow to adopt our products, which might replace or compete with their existing systems. Our efforts to educate potential customers may not result in our products achieving market acceptance.

Rapid technological changes could cause our products and services to become obsolete or require us to redesign our products. The market in which we compete is characterized by rapid technological change, frequent new product introductions, changes in customer requirements and emerging industry standards. In particular, we expect that the growth of the Internet and Internet–based telephony applications, as well as general technology trends such as migrations to new operating systems, will require us to adapt our product to remain competitive. This adaptation could be costly and time–consuming. Our products and services could become obsolete and unmarketable if products and services using new technologies are introduced and new industry standards emerge. For example, the widespread acceptance of competing technologies, such as video conferencing and the transmission of voice over the Internet, could diminish demand for our current products and services. As a result, the life cycle of our products and services is difficult to estimate.

To be successful, we will need to develop and introduce new products and product enhancements that respond to technological changes or evolving industry standards, such as the transmission of voice over the Internet, in a timely manner and on a cost effective basis. We cannot assure you that we will successfully develop these types of products and product enhancements or that our products will achieve broad market acceptance.

Our sales cycle is lengthy and unpredictable. Any delay in sales of our products and services could cause our quarterly revenue and operating results to fluctuate. The typical sales cycle of our products is lengthy, generally between six to twelve months, unpredictable, and involves significant investment decisions by prospective customers, as well as our education of potential customers regarding the use and benefits of our products. Furthermore, many of our prospective customers have neither budgeted expenses for voice and web conferencing systems nor have personnel specifically dedicated to procurement and implementation of these conferencing systems. As a result, our customers spend a substantial amount of time before purchasing our products in performing internal reviews and obtaining capital expenditure approvals. Our sales cycle has lengthened in 2001 and we cannot be certain that this cycle will not lengthen in the future. The emerging and evolving nature of the real–time voice and web conferencing market may lead to confusion in the market, which may cause prospective customers to postpone their purchase decisions.

If we fail to expand our sales and distribution channels, our business could suffer. If we are unable to expand our sales and distribution channels, we may not be able to increase revenue or achieve market acceptance of our MeetingPlace product and services. We plan to recruit additional sales personnel who will require training and take time to achieve full productivity, and there is strong competition for qualified sales personnel in our business. In addition, we believe that our future success is dependent upon establishing successful relationships with a variety of distribution partners. To date, we have entered into agreements with only a small number of these distribution partners. We cannot be certain that we will be able to reach agreement with additional distribution partners on a timely basis or at all, or that these distribution partners will devote adequate resources to selling our products. Furthermore, if our distribution partners fail to adequately market or support our products, the reputation of our products in the market may suffer. In addition, we will need to manage potential conflicts between our direct sales force and third–party reselling efforts.

Our ability to expand into international markets is uncertain. We intend to continue to expand our operations into new international markets. In addition to general risks associated with international expansion, such as foreign currency fluctuations and political and economic instability, we face the following risks and uncertainties any of which could prevent us from selling our products and services in a particular country or harm our business operations once we have established operations in that country:

·      the difficulties and costs of localizing products and services for foreign markets, including the development of multilingual capabilities in our MeetingPlace system;

·      the need to modify our products to comply with local telecommunications certification requirements in each country; and

·      our lack of a direct sales presence in other countries, our need to establish relationships with distribution partners to sell our products in these markets and our reliance on the capabilities and performance of these distribution partners.

If we fail to integrate our products with third–party technology, our sales could suffer. Our products and services are designed to integrate with our customers’ data and voice networks, as well as with enterprise applications such as browsers and collaborative software applications. If we are unable to integrate our products and services with these networks and systems, sales of our products and services could suffer.

In addition, we may be required to engage in costly and time–consuming redesigns of our products because of technology enhancements or upgrades of these systems. We may not be able to redesign our products or be certain that any of these redesigns will achieve market acceptance. In addition, we will need to continually modify our products as newer versions of the enterprise applications with which our products integrate are introduced. Our ability to do so largely depends on our ability to gain access to the advanced programming interfaces for these applications, and we cannot assure you that we will have access to necessary advanced programming interfaces in the future.

We may experience difficulties managing our future growth. We expect that any future growth may strain our management systems and resources, which could hinder our ability to continue to grow in the future. We may also experience difficulties meeting the demand for our products and services. If we are unable to provide training and support for our products, the implementation process will be longer and customer satisfaction may be lower.

We may not be able to install management information and control systems in an efficient and timely manner, and our current or planned personnel, systems, procedures and controls may not be adequate to support our future operations.

Our business could suffer if we lose the services of our current management team. Our future success depends on the ability of our management to operate effectively, both individually and as a group. If we were to lose the services of any of these key employees we may encounter difficulties finding qualified personnel to replace them.

The loss of our right to use technology licensed to us by third parties could harm our business. We license technology that is incorporated into our products and services from third parties, including digital signal processing algorithms and the MeetingPlace server’s operating system and relational database. Any interruption in the supply or support of any licensed software could disrupt our operations and delay our sales, unless and until we can replace the functionality provided by this licensed software. Because our products incorporate software developed and maintained by third parties, we depend on these third parties to deliver and support reliable products, enhance their current products, develop new products on a timely and cost–effective basis and respond to emerging industry standards and other technological changes.

Any interruption in supply of components from outside manufacturers and suppliers could hinder our ability to ship products in a timely manner. We rely on third parties to obtain most of the components of the MeetingPlace server and integrate them with other standard components, such as the central processing unit and disk drives. If these third parties are no longer able to supply and assemble these components or are unable to do so in a timely manner, we may experience delays in shipping our products and have to invest resources in finding an alternative manufacturer or manufacture our products internally.

In addition, we obtain key hardware components, including the processors and digital signal processing devices used in the MeetingPlace server, from sole source suppliers. In the past, we have experienced problems in obtaining some of these components in a timely manner from these sources, and we cannot be certain that we will be able to continue to obtain an adequate supply of these components in a timely manner or, if necessary, from alternative sources. If we are unable to obtain sufficient quantities of components or to locate alternative sources of supply, we may experience delays in shipping our products and incur additional costs to find an alternative manufacturer or manufacture our products internally.

Our products and services may suffer from defects, errors or breaches of security. Software and hardware products and services as complex as ours are likely to contain undetected errors or defects, especially when first introduced or when new versions are released. Any errors or defects that are discovered after commercial release could result in loss of revenue or delay in market acceptance, diversion of development resources, damage to our customer relationships or reputation and increased service and warranty cost. Our products and services may not be free from errors or defects after commercial shipments have begun, and we are aware of instances in which some of our customers have experienced product failures or errors.

Many of our customers conduct confidential conferences, and transmit confidential data, using MeetingPlace. Concerns over the security of information sent over the Internet and the privacy of its users may inhibit the market acceptance of our products. In addition, unauthorized users in the past have gained, and in the future may be able to gain, access to our customers’ MeetingPlace systems or our hosted services. Any compromise of security could deter people from using MeetingPlace and could harm our reputation and business and result in claims against us.

In 2001, we have expanded our service offerings to include hosted services for our customers. The success of our hosted services will depend on the efficient and uninterrupted operation of our computer and communication hardware and software systems. In addition, some of our communications hardware and software for our services businesses are hosted at third party co-location facilities.  These systems and operations are vulnerable to damage or interruption as a result of human error, telecommunications failures, break-ins, acts of vandalism, computer viruses and natural disasters. Systems failure or damage could cause an interruption of our services and result in loss of customers, difficulties in attracting new customers and could adversely impact our operating results.  In addition, if the number of customers who purchase our hosted services increases over time, our systems must be able to accommodate increased usage. If we are unable to increase our capacity to accommodate growth in usage, we could encounter system performance issues, which could harm our relationships with customers and our reputation.

We may be unable to adequately protect our proprietary rights, and we may be subject to infringement claims. Unauthorized parties may copy aspects of our products and obtain and use information that we regard as proprietary, which could cause our business to suffer. Furthermore, the laws of many foreign countries do not protect our intellectual property rights to the same extent as the laws of the United States.

In the future, we may be subject to legal proceedings and claims for alleged infringement of third party proprietary rights. Any of these claims, even if not meritorious, could result in costly litigation, divert management’s attention and resources, or require us to enter into royalty or license agreements which are not advantageous to us. Parties making these claims may be able to obtain injunctive or other equitable relief, which could prevent us from selling our products.

Dell Computer Corporation has registered the “Latitude” mark for computers in the United States and in other countries. Dell’s United States trademark registration and Canadian application have blocked our ability to register the “Latitude Communications” and “Latitude” with logo marks in the United States and the “Latitude Communications” mark in Canada. Since we believe that we have priority of trade name usage in the United States, we have petitioned to cancel Dell’s United States registration and opposed its Canadian application. The outcome of these proceedings is uncertain. If Dell’s registration for the “Latitude” mark is not canceled or if we are unable to obtain consent from Dell for our registration of our marks, we may not be able to register our marks and would have to rely solely on common law protection for these marks. We cannot assure you that we will be free from challenges of or obstacles to our use or registration of our marks.

We are subject to government regulation, and our failure to comply with these regulations could harm our business. Our products are subject to a wide variety of safety, emissions and compatibility regulations imposed by governmental authorities in the United States or in other countries in which we sell our products and services. If we are unable to obtain necessary approvals or maintain compliance with the regulations of any particular jurisdiction, we may be prohibited from selling our products in that territory. In addition, to sell our products and services in many international markets, we are required to obtain certifications that are specific to the local telephony infrastructure.

Our stock price may be volatile. We expect that the market price of our common stock will fluctuate as a result of variations in our quarterly operating results. These fluctuations may be exaggerated if the trading volume of our common stock is low. In addition, due to the technology–intensive and emerging nature of our business, the market price of our common stock may rise and fall in response to:

·      announcements of technological or competitive developments;

·      acquisitions or strategic alliances by us or our competitors; or

·      the gain or loss by us of significant orders.

Our executive officers and directors and their affiliates own a large percentage of our voting stock and could control the voting power of the common stock. Our executive officers and directors and their affiliates beneficially own, in the aggregate, a large percentage of our outstanding common stock. As a result, these stockholders are able to exercise control over all matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions. This concentration of ownership may delay, deter or prevent transactions that would result in the change of control, which in turn could reduce the market price of our common stock.

Future sales of our common stock may depress our stock price.

If our stockholders sell substantial amounts of common stock, including shares issued upon the exercise of outstanding options and warrants, in the public market, the market price of our common stock could fall.

Item 3.            Quantitative and Qualitative Disclosures About Market Risk.

Our exposure to market risk for changes in interest rates relates primarily to our investment portfolio. We do not use derivative financial instruments in our investment portfolio. We place our investments with high credit quality issuers and, by policy, limit the amount of credit exposure to any one issuer. The portfolio includes only marketable securities with maturities of three to 24 months and with active secondary or resale markets to ensure portfolio liquidity. We have no investments denominated in foreign country currencies and therefore are not subject to foreign currency risk on such investments.

The table below presents principal amounts and related weighted average interest rates by year of maturity for our investment portfolio at September 30, 2001 (in thousands).

	2001			2002			2003			Total
Corporate notes and bonds	$	2,002		$	11,821		$	2,095		$	15,918
Average interest rate	7.18		%	5.03		%	4.68		%	5.25		%
Federal agencies	$	—		$	—		$	3,074		$	3,074
Average interest rate	—			—			4.28		%	4.28		%

Currently, the majority of our sales and expenses are denominated in U.S. dollars and, as a result, we have not experienced significant foreign exchange gains and losses to date. While we do expect to effect some transactions in foreign currencies in the next 12 months, we do not anticipate that foreign exchange gains and losses will be significant. We have not engaged in foreign currency hedging activities to date.

PART II.        OTHER INFORMATION

Item 1.            Legal Proceedings—Not Applicable.

Item 2.            Changes in Securities and Use of Proceeds.

On May 6, 1999, in connection with the Company’s initial public offering, a Registration Statement on Form S–1 (No. 333–72935) was declared effective by the Securities and Exchange Commission, pursuant to which 3,125,000 shares of the Company’s Common Stock were offered and sold for the account of the Company at a price of $12.00 per share, generating gross offering proceeds of $37.5 million. The managing underwriters were Credit Suisse First Boston Corporation, Hambrecht & Quist LLC and Dain Rauscher Wessels. After deducting approximately $2.6 million in underwriting discounts and $1.1 million in other related expenses, the net proceeds of the offering were approximately $33.8 million. The Company has not yet used any of the funds from the initial public offering, and the $33.8 million has been invested in demand deposits and investment grade, interest bearing securities. The Company intends to use such remaining proceeds for capital expenditures, including the acquisition of redundant computer and communication systems, and for general corporate purposes, including working capital to fund increased accounts receivable and inventory levels.

Item 3.            Defaults Upon Senior Securities—Not Applicable.

Item 4.            Submission of Matters to a Vote of Security Holders—Not Applicable.

Item 5.            Other Information—Not Applicable.

Item 6.            Exhibits and Reports on Form 8–K.

(a)	Exhibits:
10.13		Loan Agreement dated July 16, 2001 between the Company and Rick M. McConnell and Angela A. McConnell.
(b)	Reports on Form 8–K—None

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Latitude Communications, Inc.
By:	/s/ JOSEPH J. COONEY
	Joseph J. Cooney Vice President, Finance and Acting Chief Financial Officer (Principal Financial and Accounting Officer)

Date:  November 14, 2001

EX-10.13

Exhibit 10.13

LOAN AGREEMENT

This Loan Agreement (“Agreement”) dated as of July 16, 2001 (the “Effective Date”), is by and between LATITUDE COMMUNICATIONS, INC., a Delaware corporation (the “Lender”), and RICK M. McCONNELL AND ANGELA A. McCONNELL (together, the “Borrowers”).

The Borrowers desire to borrow, and the Lender is willing to lend to the Borrowers, the amount of $400,000 on a secured basis under the terms and conditions of this Agreement.

The Lender and the Borrowers agree as follows:

1.             The Loan.  Subject to the terms and conditions contained herein, the Lender will lend to the Borrowers the amount of $400,000 (the “Loan”) on the date hereof.  The Loan and all obligations hereunder shall be due and payable on the date four years following the date of this Agreement, provided, however, that the Borrowers may prepay without penalty all or part of the Loan and the accrued interest thereunder at any time.

2.             The Note.  In consideration of the Lender’s delivery of the Loan, the Borrowers will execute a promissory note (the “Note”) in the form attached hereto as Exhibit A in the principal amount of the Loan and bearing interest at 5.02% per annum, compounded anually.

3.             Deed of Trust.  The Note shall be secured by a deed of trust in a form acceptable to the Lender (the “Deed of Trust”) given by the Borrowers to the Lender with respect to the Borrowers’ principal residence located at 753 Berry Avenue, Los Altos, CA 94024 (the “Property”).  The Lender may, if the Lender so elects, but without obligation to do so, at any time during the term of this Agreement record the Deed of Trust against the Property in the official records of the county in which the Property is located.  The Lender agrees that the Property shall be released as collateral and the Deed of Trust shall be released in full and cancelled on the Loan Repayment Date, and that Lender will take all reasonable actions to accomplish the foregoing release, including recording certain documents.

4.             Representations and Covenants of Borrowers.  Subject to the Schedule of Exceptions (if any) attached as Exhibit B, the Borrowers hereby jointly and severally make the following representations and warranties to the Lender, and acknowledge that the Lender is relying on such representations in making the Loan:

(a)           The Borrowers have the legal capacity to enter into and perform their obligations under this Agreement, the Note and the Deed of Trust (the “Transaction Documents”).  The Transaction Documents have been duly executed and delivered by the Borrowers and constitute, legal, valid and binding agreements of the Borrowers enforceable against the Borrowers in accordance with their respective terms.  The Note will be free of restrictions on transfer other than under applicable federal and state securities laws and as provided herein.

(b)           No authorization, consent, approval, license, exemption or other action by, and no registration, qualification, designation, declaration or filing with, any Authority (as defined below) or any other person is required to be made or obtained by the Borrowers in order to execute or deliver the Transaction Documents or to consummate the transactions contemplated hereby or thereby other than the recording of the Deed of Trust to perfect the security interest in the Property.  “Authority” shall mean any government or political subdivision, or any agency, authority, bureau, central bank, commission, department or instrumentality of either, or any court, tribunal, grand jury, arbitrator or mediator, in each case whether federal, state, local or foreign.

(c)           Neither the execution and delivery of the Transaction Documents nor the consummation of the transactions contemplated hereby or thereby nor the performance of or compliance with the terms and conditions in the Transaction Documents will (i) violate any Law (as defined below); (ii) conflict with or result in a breach or violation of or a default or loss of benefit under or permit the acceleration of any obligation under any provision of any agreement or instrument to which any Borrower is a party or by which any Borrower or any of the Borrowers’ properties is bound, or (iii) except as provided in the Deed of Trust, result in the creation or imposition of any Lien (as defined below) on any property or asset of any Borrower.  “Law” shall mean any judgment, decree, order, statute, law, ordinance, rule or regulation of any Authority (including common law), constitution, statute, treaty, regulation, rule, ordinance, judgment, order, foreign injunction, writ, decree or award of any Authority.  “Lien” shall mean any voluntary or involuntary lien, security interest, mortgage, pledge, charge, encumbrance, title defect or title retention agreement, except for such liens which individually and in the aggregate do not exceed $10,000.

(d)           There are no claims, prosecutions, actions, demands, suits, arbitrations, proceedings, hearings, studies, investigations or reviews pending or, to the best of the Borrowers’ knowledge, threatened against or affecting the Borrowers or any of their respective properties or assets at law, in equity or otherwise, in, before or by any Authority.  The Borrowers do not know of any reasonably likely basis for any such claims, prosecutions, actions, demands, suits, arbitrations, proceedings, hearings, studies, investigations or reviews.

(e)           The Borrowers have good and marketable title to or, in the case of leases and licenses, valid and subsisting leasehold interests or licenses in, all of their properties and assets of whatever kind (whether real or personal, tangible or intangible) free and clear of any Liens.

(f)            No Event or Default (as defined below) has occurred.

5.             Covenants.  The Borrowers hereby covenant that so long as the Note is outstanding:

(a)           The Borrowers shall promptly give written notice to the Lender of:

i)              Any Event of Default or any event which, upon giving of notice or lapse of time or both, would constitute an Event of Default; and

ii)             any event or occurrence which would cause any of the representations or warranties set forth in the Transaction Documents to be inaccurate or not true in any material respect at any time after the date of this Agreement.

(b)           The Borrowers shall not create, incur, assume or permit to exist Liens on any of its property except as set forth on the Schedule of Exceptions.

(c)           The Borrowers shall comply in all material respects with all Laws to which they or their properties or assets are or may become subject.

6.             Events of Default and Remedies.

(a)           Events of Default.Any one or more of the following shall constitute an “Event of Default”:

i)              The Borrowers default in the payment of any principal or interest due under the Note when the same shall have become due;

ii)             the Borrowers fail to observe or perform any covenant, condition or agreement in any of the Transaction Documents, which is not remedied within 10 days after the Lender notifies the Borrowers that such failure has occurred; provided that such 10 day period shall be reduced by the number of days that a Borrower knew of such failure, but shall in no event be reduced to less than 5 days;

iii)            any representation or warranty made by the Borrowers in any of the Transaction Documents shall prove to have been false, incorrect, incomplete or misleading in any material respect when made or deemed made, such representation or warranty continues to be material and the Borrowers shall fail to correct the fact or circumstance which made such representation or warranty materially false, incorrect, incomplete or misleading within 10 days after the Lender notifies the Borrowers of such misrepresentation; provided that such 10 day period shall be reduced by the number of days in excess of 5 days that a Borrower knew the information that caused such representation or warranty to be false, incorrect, incomplete or misleading in such material respect, but shall in no event be reduced to less than 5 days;

iv)           entry of a decree or order by a court of competent jurisdiction for relief in respect of a Borrower in any involuntary case under applicable bankruptcy, insolvency or other similar Laws now or hereafter in effect, or appointing a receiver, liquidator, assignee, custodian, trustee, sequestrator or similar official of a Borrower or any substantial part of his or her assets, or ordering the winding up or liquidation of either or their affairs, if such decree or order shall remain unstayed and in effect for a period of 60 days; or

v)            commencement by a Borrower of a voluntary case under any applicable bankruptcy, insolvency or other similar Laws now or hereafter in effect, or consent by a Borrower to the entry of an order for relief in any involuntary case under any such Law or to the appointment of or taking possession by a receiver, liquidator, assignee, trustee, sequestrator or similar official of a Borrower or any substantial part of its property, or any general assignment by a Borrower for the benefit of creditors, or failure by a Borrower generally to pay its debts as they become due, or any action by a Borrower in furtherance of any of the foregoing.

(b)           If any one or more of the foregoing Events of Default occur, the Lender may at any time (unless all defaults shall theretofore have been remedied) declare the entire unpaid principal of and all accrued interest on the Note immediately due and payable without presentment, demand, protest or other notice of any kind, all of which are hereby expressly waived by the Borrowers.  On any such acceleration of the maturity of the Note, the Borrowers shall immediately pay to the Lender, in lawful money of the United States, the entire principal balance unpaid on such Note and interest accrued and unpaid on the Loan to the date of such payment.

7.             Term and Termination.  The term of this Agreement shall begin on the Effective Date and end on the date all amounts under the Note are repaid in full.

8.             Miscellaneous Provisions.

(a)           Loss, Theft, Etc. of Note.  Upon receipt of evidence reasonably satisfactory to the Borrowers of the loss, theft, mutilation or destruction of the Note and in the case of any such loss, theft or destruction upon delivery of a bond of indemnity in such form and amount as shall be reasonably satisfactory to the Borrowers, or in the event of such mutilation upon surrender and cancellation of such Note, the Borrowers will make and deliver without expense to the holder thereof, a new Note, of like tenor, in lieu of such lost, stolen, destroyed or mutilated Note.  If the Lender is the owner of any such lost, stolen or destroyed Note, then the affidavit of the Lender setting forth the fact of loss, theft or destruction and of its ownership of such Note at the time of such loss, theft or destruction shall be accepted as satisfactory evidence thereof and no further indemnity shall be required as a condition to the execution and delivery of a new Note other than the written agreement of such owner to indemnify the Borrowers.

(b)           Powers and Rights Not Waived: Remedies Cumulative.  No delay or failure on the Lender’s part in the exercise of any power or right shall operate as a waiver thereof, nor shall any single or partial exercise of the same preclude any other or further exercise thereof or the exercise of any other power or right, and the Lender’s rights and remedies are cumulative to and are not exclusive of any rights or remedies the Lender would otherwise have, and no waiver or consent given or extended pursuant hereto shall extend to or affect any obligation or right not expressly waived or consented to.

(c)           Successors and Assigns.  This Agreement shall inure to the benefit of the respective heirs, personal representatives, successors and assigns of the parties hereto.  The Borrowers may not assign their rights and/or duties under this Agreement to a third party without the prior written consent of the Lender, which may be withheld in its sole discretion.

(d)           Governing Law.  This Agreement and all acts and transactions pursuant hereto and the rights and obligations of the parties hereto shall be governed, construed and interpreted in accordance with the laws of the State of Delaware.

(e)           Entire Agreement.  The Transaction Documents constitute the entire agreement of the parties hereto with respect to the subject matter hereof and supersedes all prior agreements and understandings related to such subject matter.

(f)            Modification.  This Agreement shall not be amended without the written consent of both parties hereto.

(g)           Construction.  This Agreement is the result of negotiations between and has been reviewed by each of the parties hereto and their respective counsel; accordingly, this Agreement shall be deemed to be the product of all of the parties hereto, and no ambiguity shall be construed in favor of or against any one of the parties hereto.  The Borrowers acknowledge that the Lender has made no representation or warranty to the Borrowers concerning the income tax consequences of the Loan, and the Borrowers shall be solely responsible for ascertaining and bearing such tax consequences.

(h)           Titles and Subtitles.  The titles and subtitles used in this Agreement are used for convenience only and are not to be considered in construing or interpreting this Agreement.

(i)            Notices.  Any notice required or permitted by this Agreement shall be in writing and shall be personally delivered or sent by prepaid registered or certified mail, return receipt requested, or overnight express courier or facsimile transmission, addressed to the other party at the address shown below or at such other address for which such party gives prior written notice of hereunder.  Notices sent by registered or certified mail shall be deemed to have been delivered 72 hours after deposit in the United States mail.  Notice delivered by overnight express courier or facsimile shall be deemed delivered upon receipt, as evidenced by facsimile confirmation or overnight courier confirmation thereof.

(j)            Counterparts.  This Agreement may be executed in two or more counterparts, each of which shall be deemed an original and all of which together shall constitute one instrument.

(k)           Further Acts.  Each party hereto agrees to execute, acknowledge and deliver or to cause to have executed, acknowledged and delivered, such other and further instruments and documents as may reasonably be requested by the other to carry out the purposes of this Agreement.

(l)            Voluntary Execution; Legal Counsel.  This Agreement and the exhibits hereto are executed voluntarily and without any duress or undue influence on the part or behalf of the parties hereto, with the full intent of creating the obligations and security interests described herein and therein.  The parties acknowledge that:  (a) they have read this agreement and the exhibits hereto; (b) they have been represented in the preparation, negotiation, and execution of this Agreement and exhibits hereto by legal counsel of their own choice or they have voluntarily declined to seek such counsel; (c) they understand the terms and consequences of this Agreement and the exhibits hereto and of the obligations and security interests they create; and (d) they are fully aware of the legal and binding effect of this Agreement and the exhibits hereto.

(m)          Survival.  Each of the obligations of Borrowers hereunder, and the liability of Borrowers for any failure of the representations or warranties set forth herein to be accurate and complete, shall survive the closing of the Loan described herein for the entire term of the Loan.

[signature page follows]

The undersigned have executed this Loan Agreement as of the date first written above.

BORROWERS:
/s/  Rick M McConnell
RICK M. McCONNELL
/s/  Angela A. McConnell
ANGELA A. McCONNELL
Address:
LENDER:
LATITUDE COMMUNICATIONS, INC.
By:	/s/ Emil C.W. Wang
Name:	Emil C. W. Wang
Title:	CEO

EXHIBIT B

SCHEDULE OF EXCEPTIONS

                This Schedule of Exceptions is made and given pursuant to Section 5 of the Loan Agreement dated as of the date hereof (the “Loan Agreement”), by and among RICK M. McCONNELL AND ANGELA A. McCONNELL (together, the “Borrowers”) and LATITUDE COMMUNICATIONS, INC. (the “Lender”).  The information disclosed hereunder shall be deemed to be disclosed and incorporated into any section number under the Loan Agreement where disclosure would be appropriate.  Any terms used in this Schedule of Exceptions shall have the meaning defined for them in the Loan Agreement unless otherwise defined herein.

[To be completed by Borrowers -- check one box only]

1.             ý            There are no exceptions to the Borrowers’ representations and covenants set forth in Section 4.

2.             o            The following are exceptions to the Borrowers’ representations and covenants set forth in Section 4:

                                                                                                                                                 
60;                                                         

                                                                                                                                                 
60;                                                         

                                                                                                                                                 
60;                                                         

                                                                                                                                                 
60;                                                         

                                                                                                                                                 
60;                                                         

                                                                                                                                                 
60;                                                         

                                                                                                                                                 
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60;                                                         

EXHIBIT A

SECURED FULL-RECOURSE PROMISSORY NOTE

$400,000.00	Santa Clara, California
	July 16, 2001

                FOR VALUE RECEIVED, the undersigned, Rick M. McConnell and Angela A. McConnell (together, the "Borrowers") promise to pay to Latitude Communications, Inc., a Delaware corporation ("Lender"), or order, at the principal office of Lender, or at such other place as Lender may from time to time designate in writing, the sum of Four Hundred Thousand Dollars ($400,000.00), plus accrued and unpaid interest thereon.  Except as provided below in the case of a default in payment, the principal amount of this Note shall bear interest at a rate of 5.02% per annum, compounded annually.  The entire unpaid balance, principal and interest, shall be due and payable four years from the date of this Note (the “Due Date”).

                1.             Definitions. The following terms used in this Agreement shall have the following meanings:

(a)           “Cause” shall mean (i) gross negligence or willful misconduct in the performance of the Employee’s duties to the Company; (ii) repeated unexplained or unjustified absence from the Company; (iii) a material and willful violation of any federal or state law; (iv) refusal or failure to act in accordance with any specific direction or order of the Company; (v) commission of any act of fraud with respect to the Company; or (vi) conviction of a felony or a crime involving moral turpitude causing material harm to the standing and reputation of the Company, in each case as determined by the Board of Directors of the Company.

(b)           “Change of Control” means the occurrence of any of the following events:

(i)            The stockholders of the Company approve an agreement for the sale of all or substantially all of the assets of the Company; or

(ii)           The stockholders of the Company approve a merger or consolidation of the Company with any other corporation, other than a merger or consolidation which would result in the voting securities of the Company outstanding immediately prior thereto continuing to represent (either by remaining outstanding or by being converted into voting securities of the surviving entity) at least fifty percent (50%) of the total voting power represented by the voting securities of the Company or such surviving entity outstanding immediately after such merger or consolidation; or

(iii)          Completion of a tender or exchange offer or other transaction or series of transactions resulting in less than a majority of the outstanding voting shares of the surviving corporation being held, immediately after such transaction or series of transactions, by the holders of the voting shares of the Company outstanding immediately prior to such transaction or series of transactions.

(c)           “Employee” shall mean Rick M. McConnell.

(d)           “Company” shall mean Latitude Communications, Inc. or such surviving entity immediately after a Change of Control.

(d)           “Involuntary Termination” shall mean (i) without the Employee’s express written consent, the significant reduction of the Employee’s duties, authority or responsibilities, relative to the Employee’s duties, authority or responsibilities as in effect immediately prior to such reduction, or the assignment to Employee of such reduced duties, authority or responsibilities; (ii) without the Employee’s express written consent, a substantial reduction, without good business reasons, of the facilities and prerequisites (including office space and location) available to the Employee immediately prior to such reduction; (iii) a material reduction by the Company in the base salary of the Employee as in effect immediately prior to such reduction; (iv) a material reduction by the Company in the kind or level of employee benefits, including bonuses, to which the Employee was entitled immediately prior to such reduction with the result that the Employee’s overall benefits package is significantly reduced; (v) any purported termination of the Employee by the Company which is not effected for Cause, or any purported termination for which the grounds relied upon are not valid; or (vi) any act or set of facts or circumstances which would, under California case law or statute, constitute a constructive termination of the Employee.

(e)           “Termination Date” shall mean (i) the date on which a notice of termination is given, provided that if within thirty (30) days after the Company gives the Employee notice of termination, the Employee notifies the Company that a dispute exists concerning the termination or the benefits due pursuant to this Agreement, then the Termination Date shall be the date on which such dispute is finally determined, either by mutual written agreement of the parties, or by a final judgment, order or decree of a court of competent jurisdiction (the time for appeal therefrom having expired and no appeal having been perfected), or (ii) if the Agreement is terminated by the Employee, the date on which the Employee delivers the notice of termination to the Company.

(f)            “Loan Agreement” shall mean the Loan Agreement between the Company and the Borrowers, dated as of the date hereof.

2.             Termination.

(a)           Involuntary Termination.  If the Employee’s employment with the Company is Involuntarily Terminated for any reason other than for Cause, all of the then outstanding principal and accrued interest under this Note shall become due and payable either within twenty four months following the Termination Date or on the Due Date, whichever occurs earlier.

(b)           Voluntary Termination.  If the Employee voluntarily terminates his employment with the Company, all of the then outstanding principal and accrued interest under this Note shall become due and payable either within twelve months following the Termination Date or on the Due Date, whichever occurs earlier.

(c)           Termination For Cause.  If the Employee’s employment with the Company is terminated for Cause, all of the then outstanding principal and accrued interest under this Note shall become due and payable immediately.

                3.             Borrowers’ Obligations.  Borrowers shall grant Lender a security interest in certain real property located at 753 Berry Avenue, Los Altos, California 94024 (the "Property") and shall cooperate in any manner and take such actions requested by Lender to grant, memorialize and perfect such security interest under all applicable laws, including but not limited to the preparation and filing of a customary land mortgage covering the Property, which land mortgage shall provide, among other things, that upon default by Borrowers upon the covenants and agreements under such land mortgage, the holder of this Note may declare the entire principal amount outstanding under this Note, and any accrued interest thereon, to be immediately due and payable.

                4.             Acceleration.  If an Event of Default (as defined in the Loan Agreement) shall occur, or if the Borrowers shall sell, convey or alienate the Property, or any part thereof, or any interest therein, or shall be divested of their title or any interest therein in any manner or way, whether voluntarily or involuntarily, without the written consent of the holder hereof being first had and obtained, the holder of this Note shall have the right, at its option, to declare any indebtedness or obligations hereunder immediately due and payable.  Borrowers shall notify the holder of this Note promptly in writing of any transaction which may give rise to such right of acceleration.  Borrowers shall pay to the holder of this Note direct, ascertainable and documented damages the holder may sustain by reason of Borrowers' breach of the covenant of notice contained in this paragraph.

                5.             Payment.  Amounts due under this Note shall be payable in lawful money of the United States of America and in immediately available funds free and clear of and without deduction for any present or future taxes, restrictions or conditions of any nature.  Any installment of principal due under this Note which is not paid when due shall bear interest at the rate of ten percent (10%) per annum, or, if less, the highest rate permitted by law from the date such payment became due until paid.  All payments under this Note shall be applied first to any accrued and unpaid interest and then to principal.  Borrowers shall have the right to pay, without penalty or premium, all or any portion of the outstanding principal amount of this Note prior to the date for payment specified above.

                6.             Full Recourse.  Borrowers acknowledge that notwithstanding the foregoing, the obligations under this Note are with full recourse to Borrowers and Borrowers shall have full personal liability for any amounts of principal or interest, or any other payments due under this Note, without regard to the value of the Property.

                7.             Action to Collect on Note.  Borrowers waive presentment, protest and demand, the notice of protest, demand, dishonor and nonpayment of this Note and diligence in taking any action to collect any amounts owing under this Note by proceeding against any of the rights and interests in and to the Property, securing the payment of this Note.  If action is instituted on this Note, Borrowers agree to pay such reasonable sum as attorney's fees as the court may fix and award in such action.

                IN WITNESS WHEREOF, Borrowers have executed this Note as of the date first written above.

  /s/  Rick M. McConnell

Rick M. McConnell

  /s/  Angela A. McConnell

Angela A. McConnell